REFORMING WALL STREET:

What Will Congress Do About

Corporate Governance?

John C. Coffee, Jr.

April 6, 2010

IR Global Rankings Conference

Yale Club of New York

Slide 1
 Introduction

1. In the wake of the worst financial crisis in over seventy five years, Congress is
pursuing financial reform. H.R. 4173 passed the House of Representatives in
December, and the “Restoring American Financial Stability Act of 2010” (the
“Dodd Bill”) was approved by the Senate Banking Committee on March 15,
2010 (on a party-line vote).
2. The odds are increasing that “financial reform” legislation will pass this year,
although there are broad differences between the House and Senate bills and
further compromises are likely in the Senate.
3. Much of this legislation addresses the issue of systemic risk and the “too big to
fail” phenomenon. Detailed provisions address: (1) the powers and jurisdiction
of the Federal Reserve, the FDIC, the SEC, the OTS (which will be abolished);
(2) “resolution authority” to permit the early liquidation of an insolvent, but
systemically significant firm; (3) the credit rating agencies; (4) hedge fund
registration; (5) asset-backed securitization; (6) over-the-counter derivatives;
and (7) a consumer protection agency.
4. Today, I will address none of these; instead, I intend to focus on what has
received less attention: the corporate governance/executive compensation
provisions in this legislation.

Slide 2
 PROXY ACCESS
1. Probably the most controversial change in corporate governance proposed by the
current financial reform is that set forth in Section 972 (“Proxy Access”) of the Dodd
Bill, which authorizes the SEC to adopt rules (1) enabling shareholders to submit
one or more nominees for inclusion in the corporation’s own proxy statement for
election by the shareholders to the board of directors, and (2) specifying
procedures for proxy access.
2. There was a small shift in the latest draft of the Dodd Bill, as it no longer mandates,
but instead only authorizes, the SEC to “issue rules permitting the use by
shareholders of proxy solicitation materials supplied by an issuer of securities for
the purpose of nominating individuals to membership on the board of directors of
the issuer, under such terms and conditions as the Commission determines are in
the interest of shareholders and for the protection of investors.”
3. Although this language is unqualified, the SEC is currently considering only
whether to authorize a minority slate of 1,2 or 3 directors (depending upon the size
of the board) if a requisite threshold percentage of shareholders (between 1% and
5% depending on the size of the issuer) joined in the nomination.
4. This reform is intensely controversial within the business community. Although the
SEC is divided, it is still likely to approve some form of proxy access by a 3-2 party-
line vote.
Effective Date: The SEC Must Issue Rules Within 180 Days of Enactment.

Slide 3
 Impact of Proxy Access
Why is Proxy Access so controversial? The SEC has several times proposed granting
shareholders a right to nominate directors on the issuer’s proxy statement (most
recently in 2009), but has backed off, probably because of legal questions involving its
authority.
Answers:
1. It will greatly reduce the costs of undertaking a proxy contest and make such
an effort attractive to some institutional investors (large public pension funds in
particular).
2. Arguably, it may “fragment” the board between the majority and a small camp
of one or two directors who were not chosen by the nominating committee.
3. Opponents claim it will increase pressures on the board to pursue short-term
gains at the expense of long-term planning and to increase leverage and risk.
4. Opponents point to an alternative procedures recently adopted under
Delaware law (and also incorporated into the ABA’s Model Business
Corporation Act) under which shareholders or boards may adopt bylaws
implementing proxy access in a more tailored, firm-specific fashion. (This
Delaware statutory change might have legally undercut the SEC’s proposed
rule, but for the pending Congressional legislation, which clarifies the SEC’s
authority).

Slide 4
 Remaining Issues

Assuming passage, the SEC must address a number of issues:

1. Threshold: In 2009, the SEC proposed tiered thresholds for
nomination ranging between 1% and 5% depending on the
corporation’s size.
2. “Long-Term” Shareholders: In 2009, the SEC proposed that only
shareholders who had held for a minimum period of one year could
join the nominating group in order to minimize pressure from “short
term” shareholders. The debate continues on this issue, and in the
past the SEC preferred a three year holding period.
3. Default Rules: Can an issuer set higher thresholds and how may it do
so: i.e., by a board-passed bylaw? Or only by a shareholder-adopted
bylaw?.
4. Multiple Nominations: Which nomination takes precedence: (1) that of
the first-to-file (with the requisite minimum percentage), or (2) that of
the largest nominating group. To date, the SEC has favored the former
approach as simpler, but management could possibly use that
approach to stack the deck.
Slide 5
 Majority Vote in Uncontested Elections
1. Section 971 of the Dodd Bill requires the Commission to direct the NYSE, Nasdaq
and other securities exchanges to prohibit the listing of any issuer that does not
adopt a majority voting rule for uncontested elections.
2. In a contested election when the number of nominees exceeds the number of
directors to be elected, a plurality vote will elect the board.
3. In an uncontested election, if a director receives less than a majority of the votes
cast in the election, then
(i) the director must tender his resignation to the board; and
(ii) the board of directors must either:
(a) accept the resignation;
(b) determine a date on which the resignation will take effect (within time
limits specified by the SEC); or
(c) based upon a unanimous vote of the board, decline to accept the
resignation and within 30 days disclose the specific reasons for its
decision and the analysis it was based upon.

Effective Date: The Exchanges Must Adopt Listing Rules Not Later Than One Year From
Enactment
Slide 6
 Impact
1. Majority voting is already widespread. The Corporate Library
reports that more than two-thirds of S&P 500 companies have
adopted it.
2. But the Dodd Bill requires a unanimous board vote to decline a
resignation and mandates that the board provide a detailed
justification within 30 days.
3. Practices will also change at smaller public companies, as 75%
of the Russell 3000 still elect directors by simple plurality voting.
4. During 2009, the RiskMetrics Group reports that some 91
directors at 49 U.S. companies (in the S&P 500 and Russell
3,000) received less than a majority vote (up 3 times from the
2008 proxy season). Within the S&P 500, only 12 directors at 6
companies failed to obtain majority support. Of these 49
companies, only two had director resignation policies requiring
the tender of a resignation and in all cases the directors
remained on the board. Slide 7
 EXECUTIVE COMPENSATION

1. “SAY ON PAY” (Advisory Shareholder Vote on Executive

Compensation
Section 951 of the Dodd Bill requires that the corporation’s annual
proxy statement “shall include a separate resolution subject to
shareholder vote to approve the compensation of executives as
disclosed” in the proxy statement.
This vote is non-binding and advisory (but boards may be reluctant
to disregard a shareholder vote).
Effective Date: Six months after enactment of the legislation
(Hence: proxy statements in 2011 may have to comply).
Impact: The U.K. has had this system for years, and boards
negotiate compensation with major institutional investors to assure
a favorable vote.
Note: The 2010 Dodd Bill deleted a prior provision requiring a
separate shareholder vote on “golden parachutes” as a result of
M&A activity.
Slide 8
 Compensation Committee Independence

1. Section 952 of the Dodd Bill requires that all members of the Compensation
Committee be “independent” (as defined). This provision further requires the
NYSE and Nasdaq to promulgate a definition of independence that takes
account of:
(1) total compensation, including advisory and consulting fees paid by the
issuer;
(2) any affiliation with the issuer, a subsidiary, or an affiliate.
Potentially, outside directors could simply be paid too much by their
company to be deemed independent.
2. The Compensation Committee is authorized “in its sole discretion” to retain, or
obtain the advice of, its own counsel and compensation consultant, but may
only select a compensation consultant, legal counsel, or other adviser that
meets independence criteria.
3. Each issuer shall provide for appropriate funding, as determined by the
Compensation Committee, for payment of reasonable compensation to the
consultants and counsel chosen by the committee. This overrides Delaware
law, but the board is not obligated to follow the committee’s recommendations.
Effective Date: Not later than 360 days after date of enactment.
Slide 9
 “Pay for Performance”
1. Section 953 of the Dodd Bill instructs the SEC to
require each issuer to disclose in its proxy
statement the “relationship between executive
compensation actually paid and the financial
performance of the issuer, taking into account any
change in the value of the shares of stock and
dividends of the issuer.”
2. This section contemplates a five-year chart or
graph showing how the shareholders have done in
relation to changes in executive compensation. (If
the lines cross, the picture may look bad).

Slide 10
 COMPENSATION CLAWBACKS
1. Section 954 of the Dodd Bill mandates a recovery (or “clawback”) of incentive
compensation paid based on inflated earnings that are later restated. Specifically, it
provides that:
In the event of “an accounting restatement due to the material noncompliance of the
issuer with any financial reporting requirement under the federal securities laws, the
issuer will recover from any current or former executive officer of the issuer who
received incentive-based compensation (including stock options awarded as
compensation) during the 3-year period preceding the date . . . (of the restatement)
. . . in excess of what would have been paid to the executive officer under the
accounting restatement.”
2. This language seems to contemplate that if the accounting restatement reduces reported
earnings from, say, $10 per share to say $6 per share, the corporation shall recover all
stock options and other incentive compensation that was attributable to the $4 difference
that was eliminated.
3. This language raises many interpretive questions (for example, how do we know how
much incentive compensation was attributable to the foregoing $4 difference). But this
provision is far broader than a similar provision in Sarbanes-Oxley because it covers all
executive officers (not just the CEO and CFO), looks to the 3-year period before the
restatement, and requires no finding of “misconduct.”
4. According to Equilar, in 2009, 72.9% of Fortune 100 companies had publicly disclosed
“clawback” policies (nearly all of these were adopted since 2006).

Slide 11
 Separation of Chairman and CEO

1. Beginning not later than 180 days from

enactment, the SEC must require disclosure
in the annual proxy statement of “the reasons
why the issuer has chosen the same person
to serve as chairman of the board of directors
and chief executive officer” or “different
individuals to serve. . . .”
2. In short, reasons must be disclosed in either
case.

Slide 12
 Miscellany
1. Hedging Disclosure: Section 955 requires disclosure of the ability of executives to
purchase short options, equity swaps, collars, or prepaid variable forward contracts.
Effectively, this is intended to encourage a corporate policy against hedging by
executives.
2. Excessive or Unsafe Compensation. In the case of bank holding companies,
Section 956 instructs the Federal Reserve’s Board of Governors to prohibit by rule
“excessive” compensation or compensation plans that “could lead to a material
financial loss.”
3. Whistleblower Bounties. Section 922 provides for the SEC to establish a
whistleblower fund that would reward whistleblowers who “voluntarily provided
original information to the Commission that led to the successful enforcement” of a
covered action in an aggregate amount between 10% and 30% of the “monetary
sanctions” imposed in the action. The term “monetary sanction” includes
disgorgement.
Consequence: The economic incentive to “blow the whistle” in a securities fraud
case will be greatly increased.
4. Risk Committee: All publicly traded nonbank financial companies that are
supervised by the Federal Reserve must adopt a risk committee (as must all
publicly traded bank holding companies with assets over $10 billion). The Board of
Governors may also require smaller bank holding companies to have a risk
committee.
Slide 13
 Assessment
1. Some provisions have been dropped from the 2010 Dodd
Bill, including a requirement that shareholders approve
staggered boards.
2. Of the corporate governance provisions that remain, proxy
access will have the greatest impact, and a lobbying battle
will begin over how the SEC should implement it. But the
SEC will probably stick closely to its 2009 proposals.
3. Many of the Dodd Bill’s corporate governance provisions
are implemented by requiring the stock exchanges to adopt
listing rules requiring adoption of the Bill’s governance
provisions as a condition of listing eligibility. This will raise
complex problems if a company arguably has not
complied, and direct shareholder enforcement may not be
possible. The extent to which the exchanges will monitor
and enforce is open to question. Slide 14